Linden Dollar. Another Virtual Currency Affected by FinCEN.

Bitcoin has been in the news recently. But bitcoin is not the only virtual currency. Virtual currencies, in one form or another are here to stay.

When U.S. Treasury Department’s enforcement arm, FinCEN, issued its interpretive statement, it recognized this much. The scope of this document covers all virtual currencies, centralized and de-centralized alike.

Previous post discussed the new regulatory reality faced by bitcoin and its operators. By way of quick summary, FinCEN now differentiates between user, administrator, and exchanger. This categorization for decentralized virtual currencies is imprecise because there is no clear boundary where user ends and administrator begins.

On the contrary, for centralized virtual currencies, such as Linden Dollars, these distinctions nicely track the existing framework.

Background

Linden Dollar is a virtual currency used in Second Life. Second Life is an online virtual world created by Linden Lab. Essentially, it is a game where players interact with their world through “avatars.” What makes this game special is its vibrant virtual economy. Players can buy and sell virtual real estate, claim intellectual property, etc.

At the center of this economy stands the Linden Dollar. The only way to buy or sell anything inside the game is with this currency. Players can convert their real world currency to Linden dollars either at Lindex – an official currency exchange; or at several third party exchanges.

Before FinCEN issued this guidance, the only rules that applied to Linden Dollar were those promulgated by Lind Lab through its Terms of Service. This is no longer the case. Terms of service still apply, but not to the relationship between Linden Lab and the government.

What, If Anything, Changed for a Casual Second-Lifer?

Probably nothing. Absent further clarification from the Treasury Department, existing terms of service still control the legal relationship between the user and the issuer of Linden Dollars. Section 5 of Linden Lab company’s Terms of Service emphasizes that Linden Dollar is a license token as opposed to currency. “Each Linden dollar is a virtual token representing contractual permission from Linden Lab to access features of the Service. Linden dollars are available for Purchase or distribution at Linden Lab’s discretion, and are not redeemable for monetary value from Linden Lab.”

An average user probably does not care about all this legal jargon, so long as he is able to buy and sell his Linden Dollars at will.

Linden Lab’s Terms of Service however, will not prevent the government from classifying Linden Dollars as a virtual currency. That classification carries significant consequences.

What Changed for Linden Lab?

1. Government’s Definition of a Linden Dollar.

FinCEN now considers Linden Dollar as a convertible centralized virtual currency. The guidelines define virtual currency as one that either has value in real currency or one that can be used to buy goods and services. Additionally, a centralized virtual currency is one that has a central repository.

Linden Lab does not want to consider the Linden Dollar as a virtual currency. Second LIfe’s terms of service refer to Linden Dollar as a transferable license. Also according to Linden Lab, when a player “sells” the Linden Dollar, that player transfers a license, not currency. However, Linden Lab terms of service will play no role in FinCEN’s decision to classify Linden Dollar as virtual currency.

FinCEN goes by the approach “If it looks like a duck, and quacks like a duck, it is a duck.” And Linden Dollar sure does “quack” like one. Linden dollar is a virtual currency because it has value in real currency (a buck will buy you about 270 linden bucks); and people buy good and services with it.

2. Why does it Even Matter if Linden Dollar is a Virtual Currency or not?

It matters for Linden Lab because they are now both an administrator and an exchanger of virtual currency. Both of these are a Money Services Business (“MSB”) under the treasury regulation. An MSB must register with the Treasury Department and make Anti-Money Laundering and periodic reports. These reports are not little one page chores a trained monkey can do. There is a reason corporate compliance departments are stacked with lawyers and accountants. As you can imagine both of these items cost a lot of money.

At this point Linden Lab must be considering their options. One option is to abandon the Linden Dollar altogether and just deal in cold hard cash. The upside of that decision is that it would spare them a lot of grief in the form of FinCEN reports. The downside of that is that is like turning off a printing press that prints money. And who in their right mind wants to do that?

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Why am I not convinced or impressed by FinCEN? Tateru Nino had pointed out that large-scale money laundering in SL is highly unlikely; not least because all L$ purchases and sales are carried out through Paypal or credit cards, and certainly not least because European customers of SL pay VAT automatically with their L$ purchases (a tax that is often as high as 23%). BTW, Paypal already has anti-money laundering safeguards built-in, and even LL has daily L$ transaction limits to avoid money laundering accusations.

If the American authorities want to look for large-scale money laundering and tax dodging, they should look no further than HSBC and Wachovia, two banks that have admittedly engaged in wholesale money laundering for the Mexican drug cartels – and HSBC is also involved in enabling funding of terrorist-friendly regimes, violations of UN financial sanctions and even funding of terrorist groups.

But HSBC’s execs are “too big to jail”, as the US government told us. So, who’s going to be the next scapegoat? Virtual currencies, because “teh h4x0rz” are the big money launderers, not the “honourable businessmen” of HSBC, Wachovia, Marfin Investment Group etc.

I think what FinCEN tried to do with this document is get the foot in the door to start regulating virtual currencies. Arguably the intent was to start regulating Bitcoin and institutions that accept it. They probably decided “might as well start regulating all virtual currencies, not just decentralized.” Personally, I think that Linden Lab and companies like that are the collateral damage of that regulation.

You are right though, selective enforcement or lack of enforcement is unfair and is a problem. *sigh* Such is the world we live in

Selective enforcement is the best way to ridicule any regulatory authority. If they want to do away with tax evasion and tax dodging, they should go after Luxembourg, Monaco, the Cayman Islands, Switzerland, Andorra and other such tax havens. They should start combing through the books of Lockheed Martin (and other companies of its ilk – companies that, despite their ridiculously large profit, not only pay zero tax, but get billions of dollars in tax returns – Lockheed in particular got a tax return to the tune of $4bn)…

Honestly, I am unfamiliar with those, but if they are used like L$ is used, then yes it most likely will fall under the regulation. But keep in mind. What FinCEN did is not a regulation yet. Regulations have to go through notice and comment. This document did not go through this stage yet. FinCEN is likely trying to gather information. That is usually the purpose behind guidance documents when new issue arises.